Falling gold prices take shine off gold loan companies

A high loan value and delayed auctions owing to regulatory restrictions suggest a crisis in earnings is around the corner

Ravi Krishnan livemint.com Wed, Mar 20 2013

Lending against gold is not a low-default business. Rather, it reports lower losses when defaults happen simply because the loans are secured by the precious metal. Even when gold prices are falling, risks increase, but only a bit as non-performing assets are auctioned and the money is recovered. But, when the loan value is a high portion of the gold taken as security, auctions are delayed owing to regulatory restrictions or otherwise and gold prices fall, a crisis in earnings is around the corner.

That’s precisely what has happened to Manappuram Finance Ltd. Before the Reserve Bank of India’s clampdown on interest rates and capping of advances at 60% of the value of jewellery, gold loan companies were on a credit spree. Manappuram had lent some Rs.10,500 crore in the quarter ended December 2011, analysts say. A portion of these loans were one-year bullet payment loans but have turned bad.

Here’s how it happens: A Rs.90 loan is taken for a collateral of Rs.100 worth of gold jewellery. At a 25% interest rate, the amount the financier hopes to collect a year later is Rs.112.5. If in the meanwhile the value of the collateral falls to Rs.95, it’s an incentive for borrowers to default. Sure, unless prices fall sharply, there are unlikely to be losses on the principal amount. But companies typically spread interest income over four quarters. Thus, such a situation forces them to reverse interest income…>>MORE>(Livemint.com)